‘We’re still in a phase of sell the rally rather than buy the dips’

The markets have rallied from recent lows, but GAUTAM CHHAOCHHARIA, head of India Research, UBS, tells Vishal Chhabria that macros have still not turned favourable, earnings estimates will see more cuts and retail flows have decelerated sharply. He says elections will be the biggest driver for markets. Edited excerpts: What do you make of the latest rally or rebound in markets after a steep fall? Is it is a Dead Cat bounce or you see more legs to the rally?

We see it as a Dead Cat bounce. We’re still in a phase of ‘sell the rally’ rather than ‘buy the dips’. In a tightened liquidity environment, markets will de-rate. Indian markets peaked at about 20 times forward price-earnings (PE) multiple. They de-rated back to around 16 times. This figure will change to 18 times if we realistically look at earnings, where we see estimates being revised lower. The last fiveyear average PE is 16 times. At those levels with realistic earnings, the fair value of Nifty would be 9,500 in March 2019, which is our base case.

Leave alone global factors such as US-China trade issues, a strong dollar, etc, there are various local issues such as the slowing of retail flows into mutual funds. The nonSIP flows into equities have come down sharply from a monthly average of $2 billion last year to near zero now.

While earnings cuts will again happen, the bigger driver will be elections. The markets and global investors have been presuming and pricing in that Mr Modi will come back. If that view gets tested in the elections by May, markets will correct further. The results of state elections on December 11 will be an indication. Tight liquidity means growth in the second half of FY19 will underwhelm expectations, both for GDP and earnings, and means more downsides.

But, isn’t that oil is down, rupee is stabilising, bond yields have come off—the factors which actually shook the markets?

It could help in the short term. But these are still not at levels seen about a year back. There’s been some moderation recently, but not showing underlying variables which suggest a big rally ahead.

Corporate earnings are still under pressure. What are you expecting?

India has seen earnings cut for the last six years. And every year the cuts have been quite broad-based. Our forecast of 13 per cent earnings growth for Sensex/Nifty for FY19 has not changed since January. We have seen some cuts, and we estimate a further cut of 6 per cent to consensus estimates. For FY20, we see 17 per cent growth, assuming boost from banks’ provisioning cycle.

How would you now place your investments?

Don’t take too much of sector bets as we will continue to see a lot of dispersion within sectors. The only sector bets we recommend is to be overweight retail liability-driven private banks and IT services.

We are underweight Capex. We are underweight small mid-caps as the valuation gap are still froth. Consumer staples and discretionary are still very expensive, with earnings growth growing in sub-teens and there will be likely impact of tightening liquidity too. But that’s also a place where investors hide in a falling market. So look at individual stocks with a potential earnings beat, and don’t be aggressively underweight.

What is your view on NBFCs? Are they getting back to normal?

I’m not too worried about NBFCs (non-banking financial companies) and liquidity stress per se as this is unlikely to be a prolonged systemic credit crunch. None of the NBFCs individually are so big to cause a systemic issue and the larger ones are backed by strong parents. Policymakers have to watch out for potential defaults even from a small NBFC as it may cause a vicious cycle in itself, as confidence gets shaken.

Liquidity is much better than a month back, but not yet 100 per cent normal. NBFCs are now borrowing at 50–100 basis points more, and not at 500–1,000 basis points more.

A very small percentage of NBFCs, maybe 2 –3 per cent without strong parentage, could theoretically be facing stress and be vulnerable to default.

FIIs have been buying recently after a long period of selling. Have they turned bullish on India?

We haven’t seen any big buying per se. The way I would put it is that at an aggregate level global investors were anyways overweight India. So, they trimmed a bit of the overweight over the last few months in 2018 and still trimming. India is still the biggest overweight emerging market for them even now. What would have helped is oil. A lot of investors had also looked at India as an oil proxy on both sides. So, oil coming off sharply has helped India. But otherwise, there’s no dramatic change in the stance. Sentiment near-term appears to be bearish though, as suggested by UBS Evidence Lab Market Thinking Game and from our conference.

Does the spat between the RBI and government worry your investors?

When you talk about India being a good market for them to invest, having an independent RBI does matter. I won’t speculate how it plays out. The two debating and having a disagreement is fairly common. But for it to come out in the public domain is a bit of a surprise. For now, there is no reason to believe that the RBI is not independent.

THE MARKETS AND GLOBAL INVESTORS HAVE BEEN PRESUMING AND PRICING IN THAT MR MODI WILL COME BACK. IF THAT VIEW GETS TESTED IN THE ELECTIONS BY MAY, THE MARKETS WILL CORRECT FURTHER